Diversification has been talked about to death and it's such a well known and studied 'free lunch' in the markets that almost everyone is doing it (and many would argue are over-doing it).
On the other hand, convexity is a lot lesser known to the average investor/trader. Does anyone here engage in tail-risk hedging or value investing in vol or adding convexity to their portfolios? Keen to discuss with others who may be doing something similar to me (and other tail-risk fund managers)
I believe diversification and convexity are crucial to long-term compounding of wealth and that the latter is not talked about enough. Thoughts?
byu/karhoewun ininvesting
Posted by karhoewun
3 Comments
Can you explain how you would overdo investing in a global index?
Convexity is definitely underrated but honestly most retail investors would probably mess it up trying to implement it themselves. The math gets weird fast and timing is everything with vol plays
That said, having some cheap OTM puts as portfolio insurance isn’t a terrible idea if you’re not overleveraged on the premium costs
I’m largely on the same page. Diversification is easy to accept because it usually “works” quietly, while convexity is uncomfortable because it often looks like a drag for long stretches of time. Most portfolios are diversified across assets that still end up correlated in stress events, which is where convexity actually matters.
True convexity tends to have negative carry, so people abandon it before it ever pays off. That’s why it’s more common among institutional or tail-risk managers than retail investors. You don’t need a big allocation for it to matter, though, small exposure can meaningfully change drawdown behavior and long-term compounding.
I also think a lot of investors confuse leverage with convexity. Increasing beta feels exciting, but it doesn’t protect you when regimes shift. Convexity is really about surviving non-normal markets, which is where long-term outcomes are often decided.